Insight & Analysis

When private equity takes over

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When a business is acquired by private equity, expect change. We ask an expert to describe events that could unfold for finance and treasury functions, post-acquisition. Readers of a nervous disposition, seek shelter.

A newly arrived private equity (PE) team will almost certainly make changes. Sometimes those changes will be far-reaching. For Julian Roche, Consultant at UK-based financial services specialist, Redcliffe Training, PE’s impact on the finance and treasury function can be hard-hitting.

In the run-up to the deal, a business may believe it is in reasonably good shape, finance believing its new PE owners have little to worry about. Of course, there may be some loose ends to tidy up in relation to the options packages of the former owners, for example, but nothing too challenging. “Then the storm can break,” says Roche.

Unencumbered by sentiment, PE will do everything it feels necessary to make good on its investment. And that process can be eye-opening for the incumbents. The following is a fictionalised case study, as told to Treasury Today by Roche and based on his experiences. He offers an assemblage of worst-case scenarios that are, he claims, in no way an unrealistic turn of events. Forewarned is forearmed…

Quick action

“An almost instantaneous step will be the appointment, after a brief competitive tender, of a management consultancy,” he says. “It will be charged with turning the company’s operating practices upside down in an effort to simultaneously cut costs and increase sales.” With the result of its review being made available, the finance function will be immediately charged with supporting the recommended changes.

As part of the consultancy project, finance and treasury will be placed under the scrutiny of a specialist drawn from within the consultancy. “Major changes here will be enacted almost immediately,” warns Roche.

At an operational level, additional reporting responsibilities will be foisted upon the existing teams. These will be associated with the high levels of debt the company now has, he explains. “The requirements will be seen as unduly onerous by the FD and treasurer, especially as they would have been closely involved with the financial structuring of the deal.”

Processes and procedures

Outreach to new financing sources will also be initiated. This will keep finance busy “for many long days”. There will also be pressure – which may be resisted by the old guard, until the board overrules it – to move towards zero amortisation debt financing, especially for the firm’s property assets.

There lies disappointment in the company’s hedging strategy for the old guard too. “It may have been a reasonable earner for the past two years,” says Roche, “but it will be radically altered as a result of changed forecasts, analysis of cash flow cycles, and a reassessment of transfer pricing between the sales and purchasing departments.” It will now be “more focused and much less risky”.

New hedging will be introduced to cover market risk, not just interest and foreign exchange risk. The desire to assess new market risk on an “almost real-time basis” will see the commissioning of an IT firm to deliver the necessary enterprise-wide automation software.

The firm can now expect a raft of new measures that will be quickly put in place to tighten up invoicing and payment collection procedures. “This will include what many will think is some quite ill-judged pressure on important clients who could easily defect to competitors,” comments Roche.

Further changes

The introduction of a range of metrics for finance, covering a series of tenders, will be launched for middle- and back-office functions. “Within six months, part of the team will be up for redundancy,” says Roche. “This will come about as a result of a decision to outsource a range of important functions to an organisation which neither treasurer nor FD will think up to the job.” These will include credit facility management, SWIFT integration, data warehousing, debt covenant reporting, steps to make cash more visible across the firm internationally, improving payroll efficiency, and counterparty management. “With some difficulty, finance may succeed in keeping the ERP function from being outsourced.”

Encouragement will be drawn from the release of a small percentage of notional sums under management. Just as importantly, overall middle- and back-office costs will be reduced year-on-year, partly as a result of a radical reduction in inter-company loans, fuelled by the decreasing tax advantages of group debt interest.

“A review of global tax paid by the company will also expose several opportunities that had been ‘missed’,” notes Roche. These include consolidating the finance function of subsidiaries back at headquarters and taking advantage of disparate corporate tax rates internationally prior to BEPS (base erosion and profit shifting). “These will be steps that the old guard will have resisted for many years for being ‘too reputationally risky’.”

Judgement

Organisationally, the main changes – after the usual switch of bank account signatories and assignment of duties for new directors from the PE firm – will revolve around the creation of a treasury advisory group, says Roche. “This will appear to spend too much time forecasting cash flow and working capital, worrying about the impact on covenants of scenarios that are unlikely to occur, such as interest rate rises, and using modelling techniques such as Monte Carlo that seem unnecessarily complex.”

However, the only additional net costs will be the appointment of a new compliance manager within finance. This individual, notes Roche, will promptly identify a number of regulations where the firm is in breach of statutory requirements for settlement, particularly in relation to its AIFMD (Alternative Investment Fund Managers Directive) filings, and some KYC and AML obligations. “These deficiencies will be remedied after a change of external lawyers.”

After 18 months, the company will feel confident enough to pre-empt a ratings review, against the advice of the old guard, and placing further pressure on the team. The result – no downgrade, despite the larger debt burden – will be declared a great benefit to management and shareholders alike. “The FD and treasurer won’t get to see it, however – they will have resigned three months previously.”

A work of ‘Project Fear’ style fiction? A chilling reflection of the truth? Let us know your takeover experiences, from either side of the fence.

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